Under 506(b): Read the Fine Print!
Under 506(b): Read the Fine Print!
In a recent decision, Twiford Enters. v. Rolling Hills Bank & Trust (In re Twiford Enters.), 2020 Bankr. LEXIS 2964, 2020 WL 6075691 (10th Cir. BAP 2020), the Tenth Circuit Bankruptcy Appellate Panel affirmed the lower court’s decision awarding postpetition interest pursuant to section 506(b). The disputed issue was whether a reference in the variable rate promissory notes to an internal rate index maintained by the bank was sufficiently clear and specific to support a claim for postpetition interest. The court held that it was.
Twiford Enterprises, Inc. (the “Debtor”) owned and operated a cattle ranch in Wyoming. The Debtor financed its ranching operations through five loans made by Rolling Hills Bank and Trust (the “Bank”), three of which were reflected in variable interest rate notes (the “Variable Rate Notes”) tied to an internal rate index (the “Index”) maintained by the Bank. The Variable Rate Notes were secured by both real and personal property.
After the Debtor sought bankruptcy protection, the Bank, as an oversecured creditor, filed a motion to allow postpetition interest, attorneys’ fees, and costs pursuant to section 506(b). The Debtor objected, arguing it could not verify the Bank’s calculation of pre-default interest because it was impossible to determine the applicable interest rate and the interest rate change dates for the Variable Rate Notes. The Variable Rate Notes provided that the applicable interest rate changed one day after the applicable origination date and as often as daily thereafter. The bankruptcy court ultimately granted the motion and approved the Bank’s request for postpetition interest. The court concluded that the interest rates were ascertainable from the Index and that the Index was incorporated by reference in the Variable Rate Notes.
On appeal, the Debtor argued that the bankruptcy court’s finding that the Variable Rate Notes incorporated the Index by reference was erroneous.
The Court’s Reasoning1
Section 506(b) of the Bankruptcy Code authorizes the holder of an allowed oversecured claim to receive postpetition interest. When a claim is based on a consensual lien, a majority of courts compute postpetition interest at the rate provided in the agreement or other applicable law under which the claim arose. This is referred to as the “contract rate” of interest.
The Variable Rate Notes provided that the law of Iowa governed their enforceability. Iowa state law generally looks to the intent of the parties. Contract formation requires mutual assent, which is present when the evidence reflects a “meeting of the minds.” The court noted that the doctrine of incorporation by reference requires the contract to make a clear and specific reference to an extrinsic document to incorporate that document into the underlying contract. The court concluded that the Variable Rate Notes incorporated the Index by reference.
After reviewing the terms of the Variable Rate Notes, the court found that, although the Index was not defined, the express terms of the Variable Rate Notes refer to the “Rolling Hills Bank & Trust Base Rate 2010” index. The court held that this reference was specific enough to allow a party to the contract to inquire as to the Index. The court, therefore, concluded that the Variable Rate Notes incorporated the Index by reference.
The court held, further, that each of the Variable Rate Notes provided a date upon which the interest rate would change and stated that the interest rate may change daily thereafter. The Index lists the daily interest rate and identifies the dates on which the interest rate changed. Accordingly, although determination of the interest rate under the Variable Rate Notes required additional steps beyond simply looking at the face of the notes, the determination was not impossible. And the terms of the Variable Rate Notes provided, at a minimum, inquiry notice that the interest rates could, and likely would, change. Thus, the court held the lower court did not err in awarding postpetition interest pursuant to section 506(b).
Implications and Takeaways
- Variable rate notes tying the interest rate to an index are sufficiently ascertainable to support a claim for postpetition interest pursuant to section 506(b).
- Parties should read contracts carefully before executing them, because courts will enforce their terms.
- More generally, courts may look to how specific the reference to an extrinsic document is when determining whether to incorporate it by reference into another document.